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The Rise and Fall of the
Managed Economy
In the early postwar decades the view that governments knew
how to control the economy and secure full employment was
shared by both Labour and Conservative administrations. The
policies which they adopted in pursuit of this aim were known
as 'demand management' (see the box on p. 6). But by the
1970s these policies were being repudiated by leading
members of both parties. Recent research into the history of
the managed economy in Britain has thrown new light on both
the origins of the Keynesian revolution in economic policymaking and its eventual eclipse. A re-evaluation of the policies
of the interwar period, and of Keynes's theoretical contribution
to postwar economic management, has been stimulated by the
deterioration of Britain's economic performance since the early
1970s, and by the massive rise of unemployment since 1979.
just as the mass unemployment of the 'twenties and ,thirties
gave credence to Keynesian ideas, so the economic troubles of
the 'seventies and 'eighties strengthened support for his critics.
Economic
1939
management
before
Until recently the natural corollary to views such as those held
by Stewart was that if only Keynesian ideas had been adopted
earlier, the interwar unemployment problem could have been
resolved. According to this view it was not until the
theoretical wisdom of Keynes's General Theory (which was
published in 1936) had been assimilated during the Second
World War that progress could be made towards the
permanent attainment of full employment by proper
management of the economy. Those who held this view also
believed that the major obstacle to the earlier acceptance of
Keynesian policies was the influence of a rival theory on an
unthinking, orthodox Treasury. This was the so-called
'classical' economic theory of an earlier age. A crucial premise
of this theory was that deficit-financed expenditures (see the
box on p.6) could only be made at the expense of a
comparable volume of private expenditures. As a result no
additional employment would be generated.
Offical attitudes in the interwar years, as shown in the
Treasury's internal papers, have recently been re-examined by
economic historians. (See Glynn and Booth [2] and Middleton
[3) for summaries of this research.) Two major points have
emerged. First, it has been shown that in fact considerable
progress had been made towards acceptance of
Middleton, Refresh 5 (Autumn 1987)
some aspects of the policy of demand management by 1939,
but that this owed more to rearmament and political forces,
than to Keynes and the economists.
Secondly, the Treasury view on deficit-finance has been
subject to particularly detailed scrutiny. We now have a much
better understanding of the reasons for the Treasury's rejection
of the Keynesian message before the war. As indicated above
Keynes and his postwar followers laid most stress on the role
of economic theory in determining official policy. By contrast,
recent writers have emphasised the prevailing political and
administrative constraints as limits to the potential efficacy of
the Keynesian solution. The Treasury did not, as Keynes
suggested, simply assume full employment, which would then,
of course, have made it impossible to explain unemployment
in theory or do something about it in practice. Rather, it
pointed to factors such as openness of the British economy,
and the financial market's grave mistrust of increased
government intervention. Given these features of Britain's
economic position the Treasury attached great importance to
the adverse effects which deficit-finance would have on the
confidence of bankers and businessmen. If this confidence was
lost, it would: (a) make it difficult for government to borrow,
except at high interest rates; and (b) deter industrialists from
making additions to their own capital equipment. The Treasury
argued that these two unfavourable consequences might be
more than enough to offset any gains from the initial
government spending.
The Keynesian revolution
The 1944 White Paper on Employment Policy, which
committed government to the 'maintenance of a high and
stable level of employment', has traditionally been seen as the
formal recognition of the principles of the Keynesian
revolution in Britain. However, more recent research has
revealed that the pace of official acceptance of Keynesian
ideas was much slower than previously thought. Even after the
1944 White Paper, the Treasury remained reluctant to support
long-term deficit-finance. The reason for this was not
theoretical but political: the fear that there would be an
explosion of expenditure once the fiscal discipline of a
balanced budget was relaxed. If it was conceded that some
expenditure might be covered by borrowing, the ability of
governments to resist ever-growing popular demands for more
money for housing, education, health services and so on would
be greatly weakened. The Treasury also continued to
emphasise its prewar concerns about industrial efficiency, and
argued that a policy of general demand management was no
cure for unemployment caused by structural problems in
specific industries or regions.
Tomlinson [5] went so far as to argue that there never was a
Keynesian revolution. By this he meant that fiscal policy never
became subordinate to the needs of employment creation, but
was merely used as an instrument to control inflation and the
balance of payments. While this view has found little support,
there has been wider acceptance of his more limited conclusion
that the role of economic theory in the policy process has been
overstated, and that of administrative and political factors
understated. This debate about the application of Keynesian
ideas continues. There is, however, general agreement that
during the war years the essential theoretical message of the
Keynesian revolution - that capitalist economies were not selfstabilising by virtue of some automatic market mechanism had been firmly accepted. At this date few economists would
have denied that if the economy fell into a depression, with low
levels of production and high unemployment, some form of
government intervention would be needed to stimulate demand
and help the economy get back to full employment.
In the early postwar decades the rate of economic growth in
Britain was slow compared to that being achieved in countries
like France, Germany, Italy and Japan, and there was
considerable public pressure for more rapid expansion.
The problem for economic management was that whenever
growth speeded-up, and unemployment dropped to very low
levels, the balance of payments would get worse. This
happened for several reasons: first, imports increased with the
need for additional raw materials for industry; and exports fell
as manufacturers preferred the easier option of selling in a
booming home market. Secondly, as the economy moved
closer to full capacity, there were shortages of both labour and
materials. This stimulated higher wages and prices and this in
turn harmed exports and helped imports. The result was a
serious balance of payments crisis.
The managed economy since 1945
The assessment of postwar economic management and of
Britain's economic performance must be made in the context of
the four major objectives of the policymakers. Until the advent
of Thatcherism these were: full employment, price stability, a
surplus on the current account of the balance of payments, and
economic growth. The central problem for economic
management since the war has been the incompatibility of
these objectives. Initially, the most difficult problem was to
reconcile the desire for rapid economic growth with the need
for a balance of payments surplus. Later, the main problem
faced by the policymakers was how to achieve full
employment without at the same time encouraging more rapid
increases in wages and prices. Some progress was made, but
the position gradually deteriorated to the point where Britain
seemed condemned to suffer both high unemployment and
rapid inflation, while growth remained slow and the balance of
payments weak.
This process can be seen in Fig. 1. In the top chart the solid
line shows unemployment as a percentage of the labour force,
and the broken line shows the annual rate of increase of prices.
The rise in both lines from the end of the 1960s is very
striking. The bottom chart indicates Britain's inability to escape
a recurrent deficit on the balance of payments. (The surplus (+)
or deficit (-) on the balance of payments is kept in scale with
the growth of the economy by expressing it as a percentage of
gross domestic product - GDP.) These problems of
unsuccessful economic management became the basis for
increasingly severe crises, political as well as economic. By
the 1970s this process culminated in the final rejection of the
earlier consensus on the advantages of a Keynesian policy of
economic management. We shall look briefly at each of these
dilemmas to see how this came about.
Middleton, Refresh 5 (Autumn 1987)
The government was forced to respond to this, and did so by
raising taxes, cutting government expenditure and generally
acting to reduce demand in order to slow down the growth of
the economy. This was the 'stop' phase of what came to be
known as the 'stop-go' policy of demand management. Once
economic activity had fallen to a lower level, and the balance
of payments had improved, the political pressure for faster
growth and lower unemployment would again be felt, and the
weapons of economic management would be used to- reverse
the process, cutting taxes to stimulate demand: the 'go' phase.
These cycles occurred repeatedly through the 1950s and 1960s,
and are very evident in Fig. 1.
The second dilemma which gradually emerged to cause acute
problems for supporters of demand management was the tradeoff between full employment and price stability. Initially the
record was very good: from the end of the war until 1966, the
proportion of the labour force unemployed was never greater
than 2.5%, and the rate of increase of wages and prices was
reasonably satisfactory (see Fig. 1). There was perhaps a
tendency for prices to rise more rapidly than policymakers
would have wished, but it was not seen as a major problem.
From the mid-1960s this situation changed dramatically. The
precise reasons for this are still a matter of debate. Those who
think the trouble started on the
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side of costs can point, in particular, to growing awareness on
the part of organised workers of their ablility to take advantage
of full employment to press for higher wages. This ability had
initially been restrained by fears of a return to the era of mass
unemployment, but these fears were eroded as memories of the
interwar years faded, and a new and more militant generation
entered the labour force. After 1969 this pressure on labour
costs was strongly reinforced by the actions of the OPEC oil
cartel.
On the other side of the debate are those who think costs can
only have an impact on prices if the supply of money is
increased to allow prices to rise. According to this view, it was
the failure of the governments, both in Europe and the United
States, to control the growth of the money supply which was
responsible for the acceleration of inflation in the mid-sixties.
Whatever the causes, the results of the process were very clear,
and through the 1970s Britain was made increasingly aware of
the new evil of stagnation, a previously unknown combination
of slow growth and high unemployment with rapid inflation.
Britain’s postwar economic
performance
It is important to see Britain's postwar growth record in its
historical perspective. The postwar record was good by the
standards achieved by Britain in earlier periods. For example,
the total quantity of goods and services produced each year
(real GDP) grew at an average annual rate of 2.8% over the
years 1951-73, as compared with 2.2% in the interwar period
1924-37, and only 1. 8% over the pre-World War I period,
1873-1913. However, this improvement over historical
standards was the common experience of our industrial
competitors, and their postwar rate of growth was much better
than ours: over the period 1950-73, the average for the six
original members of the European Economic Community was
over 5% p.a., almost double the British rate. We thus need to
understand both how we improved our own performance, and
also why we did not do as well as others.
It is natural to ask about the relationship between Britain's
relative success - by its own standards - in the postwar period,
and the policies of economic management. Was the Keynesian
revolution in economic policy responsible for the postwar
improvement in growth rates, and, in particular, for the
achievement of full employment? In a seminal paper of 1968,
written before the long boom of the western economies had
faltered, Matthews (reproduced in [1]) argued that Keynes's
contribution was in fact only indirect, and that full employment
could not have been the consequence of deficit financing
because the budget was in surplus, not deficit, throughout this
period. He attributed it instead to two other major features of
the postwar period. The first was the high level of capital
expenditure in industry, power supplies, transport, etc. This
was undertaken to take advantage of the favourable investment
opportunities created by the rapid technological advance in
these years, and also to make good the backlog of investment
needs which had been created during wartime and the
prolonged depression of the interwar years. The second
stimulus for activity and employment was the boom in the
world economy associated both with the rapid growth already
noted in the EEC, Japan and other countries, and with the free
trade policies which were generally introduced after World
War 11. This enal3led Britain's exports to expand much more
rapidly than had been possible in the depressed and tariffprotected markets of the interwar years.
Although Matthews was criticised for the way in which he
measured the government's surplus, the essence of his
argument survived. It was sufficient for Tomlinson [5] to
Middleton, Refresh 5 (Autumn 1987)
make the important observation that the highly fortunate set of
circumstances of the 1950s and 1960s led to an exaggeration of
the government's capacity to deliver a high level of activity and
full employment in adverse conditions. This misunderstanding
of the power of Keynesian policies was in turn a contributory
fact or in the subsequent disillusionment with demand
management. Too much was expected of these policies, and
their inability to live up to these expectations made them more
vulnerable when faced by the combined challenge posed by
monetarist economics and changes in political attitudes.
The crisis of demand management
In 1979 the consensus in support of the postwar Keynesian
revolution was broken. Thatcher's newly-elected Conservative
government formally abandoned the macroeconomic
objectives that had been adhered to (though not necessarily
achieved) by all former governments. The new administration
explicitly denied that stabilization by means of demand
management was either possible or desirable; and it asserted its
belief in an
Fig.1
Inflation, Unemployment and the Balance of Payments.
older tradition of a liberal market order with a minimum of
state intervention. It was the impossibility of reconciling full
employment with price stability which was most immediately
responsible for undermining the Keynesian era, since wage
stability had always depended in part upon the possibility of
unemployment. For a time, it was thought that all that was
required to sustain a programme of demand management was a
refinement of its techniques, and the addition of more effective
incomes policies to regulate the growth of wages. Gradually,
however, it was recognised that some more fundamental
adjustment was called for.
The other major forces which contributed to the political
success of the counter-revolution included:
* new developments in economic theory associated with
monetarist ideas;
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* increased political hostility to the power of government,
involving not only demand management but also matters like
the level of taxation and the extent of public ownership; * a
new analysis of what was responsible for the long-run decline
in Britain's relative economic position, with an emphasis on
political and cultural factors; and
* the deterioration in the international economic environment,
and the breakdown of some of the key postwar agreements on
exchange rates and trade.
Monetarism
We begin with monetarism. For policy purposes this doctrine
had two important elements: the quantity theory of money and
the natural rate ofunemployment. According to the former, the
supply of money can only change as a result of actions by the
monetary authorities; and as the money supply changes (with
other relevant factors remain ing broadly constant), the price
level will change proportionately. The cause of inflation is thus
the government's action in increasing the money supply.
The natural rate of unemployment hypothesis holds that the
economy has a tendency to return to a certain rate of
unemployment (determined by institutional factors such as the
bargaining strength of trade unions). Any policy which tries to
move unemployment away from this natural rate may succeed
in the short term, but only at the expense of accelerating
inflation in the long term. From this it follows that instead of
pursuing full employment goals macroeconomic policy ought
to be limited solely to the pursuit of a constant rate of growth
of money supply. This, in turn, would stabilize the growth of
money incomes.
Thus monetarists rule out the possibility that demand
management can affect either real output (as opposed to its
money value, which can increase as prices rise), or
employment, in the long run. In sharp contrast to the
Keynesian view that market economies were not selfstabilising, the monetarists revived the argument that they
were. For them, it was precisely this self-stabilizing property of
the economy which invalidated the whole of postwar
(Keynesian) demand management. They argued that such
policies did not, and could not, create employment, but only
inflation. In this way demand management seriously damaged
the free market economy, for which price stability is an
essential foundation.
-
Supply-side policies
A second feature of the monetarist approach to economic
policy was the emphasis on what came to be known as 'supplyside policies'. For the reasons just given they rejected any role
for demand management policies. However, they accepted that
governments could take action to improve economic
performance by microeconomic policies aimed at influencing
individual households or firms or industries from the supply
side.
One aspect of this approach which was given immediate
attention was the policy of lowering marginal tax rates for
those with high incomes. This was intended to increase
incentives, and generate increased managerial and
entrepreneurial contributions to economic progress. For those
on low incomes, the corresponding incentives were to be
achieved by a reduction of unemployment benefits (particularly
the earnings-related payments) relative to wages. Other areas of
policy approached from this supply- side perspective included
various attempts to increase competition and to reduce
monopoly powers exercised by certain groups. This was
directed particularly at the trade unions. It was believed that by
reducing trade union power it would be possible to achieve
both lower inflation and more. favourable conditions for the
modernisation of British industry.
This view was bolstered by a major study by a distinguished
American scholar, Mancur Olson [4]. He argued that slow
growth could be attributed to the development of 'distributional
coalitions': interest groups such as medieval guilds, trade
unions or employers' associations. By seeking to gain or
maintain advantages for their members, these groups slowed
down a society's capacity to adopt new technologies and to
reallocate resources in response to changing conditions. The
longer such groups were allowed to operate undisturbed, the
greater would be their power and thus their ability to retard
growth. His argument was illustrated by a wide range of cases
from different historical periods and countries; but the long
period of political and social stability which Britain has
enjoyed, without the shock of revolution or military defeat,
gives his analysis a particular relevance to the British case.
Conclusions
One valuable consequence of the recent work on the Keynesian
revolution by economic historians is that we now have a much
clearer appreciation of policy constraints facing governments
in their conduct of macroeconomic policies. The traditional
preoccupation of economic historians with the long-term can
also be used to good effect, given that the roots of the 'British
disease' clearly predate Keynes, let alone his legacy of demand
management. The task now is to use this information and
understanding, and to work with other disciplines to produce a
broader and better analysis of Britain's economic problems.
Reference
(1) C. H. Feinstein, (ed.) The Managed Economy: Essays in
British Economic Policy and Performance since 1929
(Oxford University Press, 1983).
(2) S. Glynn and A. Booth, (eds.) The Road to Full
Employment (Allen and Unwin, 1987).
(3) R. Middleton, Towards the Managed Economy: Keynes, the
Treasury, and the Fiscal Policy Debate of the 1930s
(Methuen, 1985).
(4) M. Olson, The Rise and Decline of Nations: Economic
Growth, Stagflation and Social Rigidities, (Yale
University Press, 1982).
(5) J. Tomlinson, British Macroeconomic Policy since 1940
(Croom Helm, 1985).
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Middleton Refresh 5 (Autumn 1987)
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